Washington Driving These Stock Ideas

As the markets balk in the face of big round numbers (16,000 on the Dow, 1800 on the S&P 500, 4000 on the Nasdaq), and as Obamacare's troubled rollout has sucked the political oxygen out of Congress, Washington may nevertheless be a source for investment ideas. Three I'll mention here involve auto dealers, dredging companies and the drug manufacturer Regeneron (REGN).

Particularly interesting may be the auto dealers (CarMax (KMX), AutoNation (AN), Group 1 Automotive (GPI), Sonic Automotive (SAH), Asbury Automotive Group (ABG), Penske Automotive Group (PAG) and Lithia Motors (LAD)). These stocks have beaten the S&P for five years straight, but they have paused since September as sales data finally showed a decline and the 16-day government shutdown further slowed consumers in October.

Bulls still point to the 11-year high average age of vehicles on the road and to forecasts for continued solid sales growth in 2014. But bears growl that the Consumer Financial Protection Bureau has targeted as discriminatory the discretionary dealer markups on auto loans (within a 2.5% band above lender "buy rates"). What's likely to happen?

While the bureau is precluded by statute from jurisdiction over auto dealers, director Richard Cordray seems resolved to effect a "bank shot" by forcing a new dealer compensation scheme via legal action or regulation aimed at auto lenders, which are fair game. And despite pushback from dozens of House and Senate lawmakers, including members of the Congressional Black Caucus and some of the Hill's most vocal liberals, CFPB officials hosting an Auto Finance Forum last week still seemed determined to force action.

While not backing away amid the withering pushback against an earlier thrust of mandating a flat fee per transaction, Cordray now says the bureau may instead try to impose "a fixed percentage of the amount financed, or other nondiscretionary approaches that market participants may devise."

Either way, CFPB action to force a new dealer-lender relationship, and thus a dealer compensation paradigm, could obviously pose a threat to the dealers, given that such incentive "participations" or "reserve" payments have represented as much as a quarter of the industry's pretax profits.

Meanwhile, while it's not sure whether or when the bureau might begin a rulemaking process, legal experts are betting that the bureau will launch anti-discrimination, "disparate impact" cases upon a few large banks and indirect auto finance companies sometime next year. According to the law firm of Ballard Spahr, related settlements "will force the lenders to employ alternative dealer compensation systems to mitigate fair lending risk."

My point is not that Cordray and the CFPB will be unreasonable. On the contrary, one of the reasons that the former Ohio attorney general was finally able to overcome a GOP Senate filibuster to win formal confirmation in July is that he had earlier threaded the needle on the crucial "qualified mortgage" rule that will dictate U.S. home loan features for decades to come. With rare positive industry and bipartisan response on the "QM" as prologue, I'd expect the bureau to similarly steer a middle course on controversial auto loans -- albeit one that will still clearly affect what it sees as $25 billion in annual higher borrowing costs as a result of poorly disclosed dealer discretion in marking up rates.

So a day of reckoning seems inevitably coming, but possibly not for months and likely not in a way likely to wreck the industry, just ding it, and one that could even face a serious threat of bipartisan congressional rebuke. Thus a bet on the auto dealer stocks, long or short, may have to take into account multiple factors, ranging from the final come-to-Cordray and the Fed's timing for a tapering to an inevitable tapering (though still impressive) sales pace and the prospects for another government shutdown, which I'd happily say are slim.

Meanwhile, other notable stories, such as dredging companies (Great Lakes Dredge and Dock (GLDD) and Orion Marine (ORN)), might benefit from a water infrastructure bill that's now in House-Senate conference committee. That bill is likely to boost harbor maintenance funding by 25% when finally enacted in December or January. But there's a chance that the intense budget backdrop could push that uptick to fiscal 2015, which won't begin until next October, and that means delayed gratification.

Separately, passage of drug compounding legislation should help Regneron, because it would reduce encroachment on that company's macular degeneration drug Eylea. But here, Regeneron's shares are already up 50% this year, and it's not clear how much a positive the new bill's voluntary regulatory structure might be. So on this one, you may want to consult an expert.